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Ivestment: Antibiotics no help against global market virus,

By Craig B Pheiffer

It’s very often been said that when Wall Street sneezes the rest of the world catches a cold. While each country’s bourse is driven by the economic fundamentals of that country (interest rates, exchange rate, economic activity, business and consumer confidence, and corporate profits) it is frequently difficult to buck the trend of the major markets in any significant way.

There is no place to hide when the big guns crash and the global bourses normally collapse in a collective heap. That’s not to say that individual indices or market groups (e.g. emerging markets) can’t deviate from the global trend from time to time. The major international markets remain, however, a key driver of the well-being of the other bourses around the globe.

The strength of the relationship is important because it begs the question whether our market can do well while the American markets, for example, perform poorly. The question is relevant at this time because our own market is still fairly cheaply valued at around an 11,7x price/earnings (PE) ratio while the valuations of the American markets are still fairly expensive. Can one buy the JSE now while it is still offering value or will the American markets stutter and make the Johannesburg Stock Exchange even cheaper?

In considering that question, the performance of the JSE in recent years has, to a degree, deviated from global market trends, largely as a result of the wild swings that we have experienced in the currency. In 2001 when the bottom fell out of the rand, the rand-hedge stocks had a field day and the JSE significantly outperformed its global peers. While the JSE gained around 25% in 2001, the Dow lost 7%, the NASDAQ gave up 21%, the big eastern markets lost 24% each and European markets were down by between 15% and 20%.

The better performance of the rand-hedge stocks in that year was a result of the higher earnings of those companies when foreign currency earnings were converted into rands, and also because of the higher rand prices of those counters when the foreign prices of the dual-listed stocks were translated into the local currency. In 2002 the rand was in transition from a highly undervalued position back to a fairer value level and then beyond. The JSE lost about 13% in that year in line with the 17% decline in the Dow, the 18% fall of the Hang Seng and the Nikkei and the 17% loss on the Brazilian Bovespa, but out of line with the losses of 31% on the NASDAQ and the much larger falls in Europe (e.g. Dax -44%). Just as the weak rand brought about a relatively stronger market when the world markets were weak, the stronger rand of 2003 has seen the JSE underperform the rest of the world as those markets have improved.

Rand-hedge stocks took a beating both in rand earnings terms and in price translation terms. In early October the JSE was still down 2% for the year while the Dow was up 15%, the NASDAQ was up 40%, the eastern markets were up 18% and the Bovespa had gained 52%. Clearly the rand, a more market-specific factor, caused the JSE to deviate from the general trend in 2001 and 2003 while the market largely kept pace with the declining pack in 2002.

While specific domestic conditions, such as the rand, have caused the JSE to decouple itself from global trends previously, the closer relationship with the international markets can be gleaned from an examination of the composition of the local market and its representative index, the FTSE/JSE All-Share Index (code J203). As at the end of business on Friday 3 October the FTSE/JSE All-Share Index comprised 158 stocks with a total market capitalisation of R1,413 trillion (R1 413 billion). The individual market capitalisations of the stocks included in the index range from R194,7bn in the case of Anglo American, down to R84,8m in the case of A-Prop at the bottom of the list.

There are of course many more listed stocks on the JSE, some with higher market caps than A-Prop, but these are excluded from the index according to the various FTSE rules of index construction. The top ten stocks in the index by market cap comprise 51,25% of the total weight of the index and have a market cap of R745,5bn. In other words the movement of the top ten stocks explains just over half of the move in the All-Share index each day. Similarly the top 20 stocks comprise 70,84% of the index’s weight and have a market cap of R1 026bn while the top 40 stocks make up 84,4% of the index’s weight and have a total market cap of R1 221bn. It’s not hard to see why the top 40 stocks get so much attention and why stocks outside that elite band attract very little analyst and institutional interest.

Looking at the index according to listing status, the seven stocks with a primary listing on the London Stock Exchange (LSE) and the one stock (Richemont) with a primary listing on the Swiss Exchange collectively make up just over a third (35,6%) of the weight of the FTSE/JSE All-Share Index. If one were to add to that tally of eight stocks the 13 stocks with a secondary listing on the LSE, then those 21 stocks would make up 55,72% of the weight of the index and have a combined market cap of R808,3bn. It is clear that with a third of the market’s capitalisation tied up in primary listings offshore, and with prices set by the traders on those exchanges, the players on the local market are more often than not relegated to mere price takers. The addition of secondary listings on the major exchanges and depository receipts on the New York Stock Exchange, or NASDAQ, increase that influence further. Clearly when international investors mark down their shares, our own international counters are marked lower and overall the JSE cannot escape the rot.

On a pure valuation basis, the local market is not expensive despite having improved from a 9,0x P/E ratio in April to almost 12x currently. Essentially the improvement in the value of the market is accounted for by the 350 basis point reduction in interest rates (the cost of capital) over the period. At the same time the American markets have had a good run and are still highly valued in P/E terms making them vulnerable to any signs of a stalling in the economic recovery or disappointments in corporate profits. The October earnings season began in the second week of the month and provided the market with some direction, one way or another. Investors sitting on a cash pile at present shouldn’t sit and wait for a wholesale collapse of the local market to get in but should rather start committing money to the market as and when bouts of weakness arise.

The current volatility in the market frequently provides investors with more than one opportunity to get into or out of individual stocks and entry levels should be carefully chosen. Any weakness in offshore markets that translates into local market weakness should be seen as an added opportunity to increase local market exposure. The same can be said for any further quick gains in the currency which cause the market to fall back.

Craig B Pheiffer is Chief Investment Strategist for Sasfin Frankel Pollak Securities. He can be contacted on Tel. +27 11 809 7500.

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The Big Change is a business strategy blog and newsletter published by Arthur Goldstuck, managing director of World Wide Worx, a leading technology research organisation based in Johannesburg, South Africa.

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